Topic Knowledge/Application
Technological Invention – Making something
Change entirely new/did not exist
before e.g. microprocessor
Innovation – Improvements on
something that has already
been invented e.g. Apple’s First
iPod
Objectives of Profit Maximisation
Firms MC = MR
Apple - £400 per iPhone
Oligopolies Only a few large firms
dominating the market
Specifically when the 5 firm
ratio is more than 60%
Analysis
Improves Productivity
Lower Barriers to Entry
Lower starting Costs
Improves Efficiency
Lower Cost of Production
Reduced Need for Physical
Premises e.g. Missguided
Lower Prices - CS
Increased Choice
Encourages LR Dynamic Efficiency
Provides Perfect Information –
Maximise Utility
Supernormal Profit
High Dividends
Lower Prices CS
Dynamic Efficiency
Allocative and Productive
Inefficiency
Revenue Maximise MR = 0
Lower Price – Increased CS
Allows for Increased Market Share
E.g. Amazon Kindles at Cost Price
Satisficing
Prevents future high costs
E.g. Pret (no waste), DPD (all
electric cars)
Assume MC = MR
Supernormal Profit AR > AC
High Prices – Lost CS
Allocative Inefficiency P > MC
Evaluation Government Policies to Solve
Creative Destruction (unemployment) but Reduce Patent Power
competition and improved efficiency is
better for societal welfare
Microsoft 92% - 20% of Computers
Depends on Industry – may erode, or
encourage monopoly power
- Could have monopoly or perfect c.
Could encourage Patent Power
E.g. Microsoft
Consumer Data Could Exploit Consumers
e.g. FB
Most are free to use at point of
consumption – so altering price would be
ineffective
Divorce of Ownership and Control Maximum Price
(Principle Agent Problem)
- Owners want high dividends Windfall Tax
- Managers want higher market
share for higher salaries and perks
Knowledge of MR = MC is imperfect
Even if a Firm Revenue Maximises, likely in
the LR they will Profit Maximise
E.g. Netflix now increasing price £1-2
Collusion Occurs Strong enforcement to Deter
E.g. BA and Virgin 2007 £270 million Cartels – not worth risk
OPEC
Consumers are exploited – reduced CS Quality Checks
 Big 4 Supermarkets – 70%
Duopoly Coke and Pepsi – 70%
Big 6 Energy – 75%
Telecoms Big 4 – 85%
Differentiated Goods – Less
likely to be substitutes so Price
Makers
High Barriers to Entry and Exit –
Supernormal profits in LR
Interdependence
Non-Price Competition
Monopoly Neo-Classical view is that one
dominant firm has 100% market
share
Monopoly Power is 25%
E.g. Google 92%
BT 33%
Tesco 27%
British Gas 27%
Apple 50%
Luxottica Eyewear 73%
Differentiated Goods so Lack of
Substitutes = Price Makers
Higher Barriers to Entry/Exit –
Supernormal Profits in LR
Imperfect Information
Heavily Regulated by CMA as
likely to exploit Consumers
Welfare Loss
CS appropriated by Producer
(Closer to AE than monopolies, as
oligopolies still must compete)
Very close to Productive Efficiency
High Economies of Scale
Keep Costs Low
Keep Prices Low
Still Generate Profit
Dynamic Efficiency – especially
Cartels
Interdependence – Kinked Demand
Not worth Increasing or decreasing
price
Game Theory (collusion)
Profit Maximise MC = MR
Supernormal profit AR > AC
High Prices – Lost CS
Allocative Inefficiency P > MC
Welfare Loss
CS appropriated by Produce
Productively Inefficient – Because
of Lack of Comp. Or Diseconomies
of Scale
Dynamically Efficient – Reinvest
Patent Power
Cross Subsidisation
All round Inefficient
Misallocation of Resources (currently oil)
Brand Loyalty Affects the impact of
Lowering Prices
May not choose to Reinvest profits
(Divorce of Ownership and Control)
Supernormal profit may not be reinvested Maximum Price
(Divorce of Ownership and Control) Likely to Cut cost in order to
maintain Profit
May Revenue Maximise in SR (Amazon),
but in the LR is likely to Profit Maximise Quality Checks
Contestability/Threat of Entry Profit Control
However, monopolist is likely to build Inefficiency
barriers to entry
(Adverts/ Predatory pricing) Windfall Tax
Shell £14 billion 2021
Natural Monopoly Argument Bp £13 billion 2021
Falling LRAC
Continuing Economies of Scale Merger Policy
Huge Fixed Costs Asda and Sainsbury’s
High MES EE and BT (Takeover)
Avoid Wasteful Duplication of Resources O2 and Virgin Media
A Monopoly is purely theoretical, in Privatisation/Nationalisation
context monopoly power means firms will
still face competition e.g. Tesco Deregulation
Contestable No Barriers to Entry = High
and Non- Threat of Entry
Contestable Large Pool of Potential Entrants
Perfect Information
Incumbent Firms are vulnerable
to Hit and Run
Baumol Theory
Firms are not simply
contestable or incontestable,
there is a degree of
Contestability
E.g. Taxi Drivers
Nationalisation Transfer of Assets from the
Private to the Public Sector
E.g. Railways in Scotland
Privatisation Sale of Government owned
Assets to the Private Sector
Firms cannot sustain production at
MC = MR
Supernormal Profits attract new
entrants
Reduce Price and Increase Quantity
Increased CS
Better Allocative Efficiency
Maybe more Productive
Lower Cost
Lower Prices
Benefit from Economies of Scale
that new firms will not have
Firms should continue to cut cost,
in case potential entrants become
a reality
Dynamic Efficiency is unlikely to be
achieved
Natural Monopoly
Continuous Economies of Scale
Falling LRAC
Huge Fixed Costs
High MES
Avoids the wasteful duplication of
Resources
Allocative Efficiency
Public Sector Considers Private and
Social Costs/Benefits
Maximise Social Welfare
Social Optimum
Lower Prices – Higher CS
Lack of Supernormal Profits
Likely to form a
monopoly/oligopoly
(If barriers to entry are high)
Firms are incentivised for efficiency
Firms may be hesitant to expand by fear of Regulation to prevent anti-
Hit and Run Entry competitive pricing
Reduced Economies of Scale
Nationalisation/Privatisation
Quality may be sacrificed to Reduce costs
However taking shortcuts harms LR market Deregulation e.g. Airlines
share Ryanair – No Frills Service
Creative Destruction Subsides to Small Firms
Incumbent firms shut down and
unemployment
Benefits of Competition outweigh costs
Other Barriers to Entry may remain high
E.g. if incumbent firms generated Barriers,
Government will struggle to fix this
Inefficient as state lack profit incentive to Public Private Partnerships
keep costs low Competitive Tendering
Productive Inefficiency Firms buy franchises from the
X-Inefficiency Government
Moral Hazard However, even with this policy,
large Government subsidies are
Diseconomies of Scale if too Large still required (£3-4 billion)
Opportunity Cost, Budge Deficit
Depends on current size of Private Firms
Small = nationalisation can bring about
greater benefits of EoS
Contracting out of services is likely to Public Private Partnerships
increase Government Cost Competitive Tendering
Opportunity Copts, Budget Deficit Firms buy franchises from the
Government
 Generates significantly high
Gov. Revenue to reduce
National Debt
E.g. Royal Mail
£3.3bn
Deregulation The removal of rules and
regulations in order to increase
the efficiency of markets
E.g. Air Traffic Regulations and
Flight Tax
Encourages Ryanair – No Frill
Service
Up to 40 competitive low cost
airlines
Perfectly Theoretical
Competitive Infinite number of employees
Labour Markets and employers
All workers homogenous
Firms and workers are Wage
Takers of equilibrium wage rate
No Barriers to Entry/Exit into a
Profession
Perfect Knowledge
Perfect Mobility of Labour
E.g. Closely related – factory
workers
Imperfectly Monopsony – A market with a
Competitive single dominant buyer of labour
Labour Markets Monopsony power is the
difference between MRP and
wage offered by monopsonist
Government for School
Teachers
NHS for nurses
Profit Maximise
Supernormal Profits
Dynamic Efficiency
Or could become like Perfect
Competition
Normal Profit
Allocative and Productive Efficiency
More like Perfect Competition
Allocative Efficiency
Productive Efficiency
Lower Cost – Higher CS
Normal Profit – Less Dynamic
Efficiency
All workers are homogenous so all
workers will be offered equilibrium
wage rate
(No wage Differentials)
Supply = MCL = AC = Wage
Firms are profit maximisers, will
only employ up to where
MRP = MCL(Wage)
In a competitive Labour market,
wage and quantity is offered where
AC (Supply) = MRP (Demand)
A monopsony can afford to profit
maximise (MRP = MCL)
Lower Wage
Less Employment
Natural Monopoly Argument However, even with this policy,
Continuous Economies of Scale large Government subsidies are
Falling LRAC still required (£3-4 billion)
Huge Fixed Costs
High MES
Avoids Wasteful Duplication of Resources
High levels of Competition may force Regulation is necessary to
investment in Dynamic Efficiency Prevent Market Abuses
If non-legal barriers to entry are still high,
firms will not enter the market
(Monopolies/Oligopolies will form)
Quality may be reduced
Unlikely as competition is still high
Labour is not homogenous
Different MRPs
Leads to Wage Differentials
Incentive to Gain Qualifications
Geographical and Occupational Immobility
Imperfect Information
Trade Unions and NMW
Monopsony Employers
Promotion of Trade Union Power
E.g. Unison, National Education
Union
NMW
£9.50/hour
 Amazon has some degree of
Power as it is a huge employer
of factory and delivery workers
Trade Unions A group of workers which make
use of collective bargaining to
increase their wages
E.g. Unision
National Education Union
Shows that monopsonies exploit
and under-employ workers
Bargain for wages higher than
competitive Wage Rate
Increased wage
Higher Disposable Income
Higher Standard of living
Higher Cost to Firm
Reduce Quantity Employed to
maintain profit
Increased Unemployment
Strength and Power depends on Union
Density
Determine whether actions like strikes will
actually make a difference
State of Economy – Boom
Firms may shut down, further increasing
unemployment
Regulation to Reduce Union
Power
Maintain international
competitiveness of economy
E.g. unions are only allowed to
strike if a certain percentage
agree in a vote

Opportunity Cost for State Wages

Trade Union Working in Monopsonies

NMW A statutory minimum wage Increased Wage
used to increase the earnings of Higher Disposable Income
the low paid Increased Living Standards
£9.50/hour Reduced Poverty
Higher incentive to Work
Increased Tax Revenue
(Direct and Indirect)
Increased Productivity
Increased Cost for Firms
Reduce Q employed to maintain
profit
Increased Unemployment
Establish the higher wage where MC = MR
Increases wage without increasing
unemployment
Comparison to National Living Wage Subsidies for Workers
20% of UK Still Live in Poverty
Level of Unemployment is dependent on
Elasticity of Demand and Supply for L
Government Failure - Low skilled are likely
to lose jobs first, despite NMW being
implemented to protect them
In-work Poverty – Cost of Living Crisis

Opportunity Cost for State Wages

Higher costs = higher Prices

Encourage Training and Education so that

MRP > NMW

Discrimination When workers are paid
different wages, for equal work,
with no different skill sets or
costs of employment
UK has Gender Pay Gap of 7.9%
5th Largest in Europe
Income, Wealth Income – A flow of money to a
and Poverty factor of production (usually
labour)
Wealth – A stock of valuable
assets such as property/shares
Relative Poverty – Earning less
than 60% of the country’s
median income (22%)
Absolute Poverty – When
people cannot afford the basic
necessities to sustain life
Gini coefficient = 0.34 before
Pandemic
0.363 now (More unequal)
Indirect Tax for A good which is over consumed
Demerit Goods in the free market
E.g. Alcohol and Cigarettes
A Tax on spending
E.g. £200/tonne of plastic not
made from >30% recycled
Perceived MRP of the
discriminated group is lower than
Actual MRP
Reduces Demand for these workers
Leads to Underemployment and
Low Wages
Reduces Cost for employers
Lower Prices
Incentivises people to gain skills
and qualifications to earn high
incomes
Economic Growth
Trickle Down Effect
Strain on Welfare System
Poor Educational Attainment
Poor Health
Poverty Trap
Poverty Cycle
MPB > MSB
Cost to 3rd Parties (NHS)
Consumers ignore social benefit
Over-Consumed
Welfare Loss from Socially
Optimum Level
Self-Employed are not Eligible
Recent Court Ruling for Uber Drivers
Workers may boost their wage if they Government Legislation
prove their productivity Gender Discrimination Acts
However, this is dependent on the Equality Acts
employers attitudes towards the group Governments must enforce
Higher Opportunity Cost
Strikes and Disputes – Extra Cost
Lack of Diversity
Will fail to attract most
desirable/productive workers
Economy is below productive potential
Brain Drain
Social Tensions Progressive Taxes
Crime and Rioting Disincentivise work
Voluntary Unemployment
Rich have a high MPS so trickle down is Brain Drain
unlikely to occur Slower Economic Growth
Low Social Mobility NMW
High Opportunity Cost Benefits
Jobseekers Allowance Disincentivise Work
Universal Credit – Calls for £20 rise to be
reinstalled Education and Training
Furlough Scheme – 9.3 million people Increase MRP
Could have been more efficient without? Takes Long Time
Inelasticity means price will increase, Instead opt for Minimum Price
quantity will not decrease proportionally
Regressive Information Provision
LR Gov. Revenue can be hypothecated
 Sugar levy 18p per litre of drink
5-8g of sugar
Cigarette Tax generated Gov.
£8.8billion 2020
Subsides for A good which is under
Merit Goods consumed in the free market
E.g. Dental Care
A payment made to producers,
to encourage increased
production of a good/service
CAP – 60 billion Euros
US Subsidy for Dairy and Meat
$38 billion
State Provision A good which is not provided by
of Public Goods the free market (Complete
Market Failure)
Must be non-excludable and
non-rival
Free Rider Problem
e.g. Flood Defences
Government providing
resources so that they are free
at the point of consumption
E.g. Education and Healthcare
Increases the cost of Production
Likely to be inelastic, so much of
the tax is passed onto the
consumer
MPC shifts Upwards
Price Increases
Quantity Decreases
Now at Socially Optimum level
MSB > MPB
Benefits to 3rd Parties (Growth)
Consumers ignore social Benefit
Under-Consumed
Welfare Loss from Socially
Optimum Level
Reduce the Cost of Production
MPC Shifts downwards
Price Falls
Quantity Increases
Now at Socially Optimum level
State maximises social welfare by
considering private and social costs
and benefits
State provision allows for universal
Access
State allocates resources at the
socially optimum level of fixed
supply
Does lead to Excess Demand
No-one is excluded from the most
important of goods
Government Failure – Black Market selling
unregulated Goods
Cigarette Black Market is estimated to be
worth £2billion per year
Nanny State
However price mechanism still allows
consumers to choose their own behaviour
To what extent is the subsidy passed on for Instead opt for Maximum Price
Lower Consumer Prices This would cause large Excess
Demand
Government Failure – Firms using subsidy
to pay off debt/increase wages Information Provision
Elasticity State Provision
LR financing via higher Taxes
Opportunity Cost
Size
Technology is making the provision of Determine a role for the Private
public goods more excludable Sector
E.g. Dart Charge (Quasi-Public Good) Ideally those who can afford
Perhaps state provision is not always private provision should pay for it
required to reduce burden on public
services
High Opportunity Cost which must be However, public goods must be
funded by Tax non-excludable
E.g. 1.25% National Insurance increase for Rich would not tolerate well
Health and Social Care Levy paying high taxes for public
goods, that they are not eligible
Dealing with Excess demand to use
E.g. Waiting Lists
Strain on Public Services
State Run Organisations are inefficient
Lack Profit Motive
Minimum Price A price floor placed above the
free market equilibrium, below
which the price cannot fall
E.g. Alcohol Consumption
Price is increased
Quantity Demanded falls to the
Socially Optimum Level
Quantity Supplied Increases
Excess Supply
Intervention Buying would not take place Tax
for Demerit Goods Creates Government Revenue
As a result, producers would be at a loss Hypothecation
Inelastic so likely to not reduce Quantity
Demanded much
Would require a very high min. Price
Regressive

Has been effective in Scotland and Wales

(Scottish Alcohol Consumption fell by 7.7%)

Government Failure – Setting Price at right

level to eliminate negative externalities by
accounting for social cost

Government Failure – Black Market

Maximum Price A price ceiling below the free
market equilibrium, above
which price cannot be
E.g. Energy Cap
Risen by about 54% by about
£700
40% of UK in Fuel Poverty
Main cause of Cost of Living
Crisis
Information Information Failure – When
Provision economic agents do not know
everything they need to know in
order to make a fully informed
decision
Asymmetric Information –
Information failure where one
economic agent knows more
than the other, giving them
more power in the transaction
Price is decreased
Lower profits to firms
Quantity Demanded rises
Quantity supplied falls
Large Excess Demand
Consumers become more aware of
the MSB of their consumption
Shifts MPB closer to MSB
(Or all the way)
Price and Quantity are Closer to
Socially Optimum Level
Welfare Loss is Reduced
Formation of a black market as an
alternative method of accessing good
Leads to Price Exploitation
Reduce excess demand by excluding those
who do not need Max. Price
E.g. Rent Controls only for those with
incomes below a threshold
Size of Maximum Price – 40% in fuel
poverty
Effective in reducing smoking since late
1900s
Opportunity Cost
Could be funded from Taxation
(Hypothecation)
Government Failure – Low Quality
Information
e.g. Low Uptake of the Green Homes Grant
Subsidise Production to increase
supply and reduce excess
demand
State provision to increase supply
and reduce excess demand
Changing the price (either
through taxation, subsidies or
price controls triggers the price
mechanism)
Signals to change
Incentivises Change
Rationalises the Change
And Allocates Resources more
efficiently
Could be more effective
 Irrational Decisions
Government providing
information in the forms of
Campaigns and Adverts to
increase consumption of merit
goods and decrease
consumption of demerit goods
E.g. Anti-Smoking
Better Health Campaign
Sport England – Uniting the
Movement Campaign
Regulation Rules/Laws used to control or
restrict the actions of economic
agents, in order to reduce
market failure
Regulation carried out by
regulatory bodies e.g. OfGem
E.g. Banning of Smoking in
Public Places
Legal Drinking Age
Banning of new fuel cars from
2030
Depends on regulation, may
increase/decrease supply or
demand
Reduce Welfare Loss
Reach Socially Optimum Level
Consumers are only looking to maximise
private utility
May not effect their behaviour
Requires a long time period
Marketing power of Firms/ Brand Loyalty is
stronger than Government Campaign
Likelihood of effectiveness is dependent on May Consider:
enforcement and punishments for
Breaking Regulation Tax
Opportunity cost Subsidy
Especially of enforcement, otherwise there
is no point in implementing Price Controls
Difficult to set at correct level Information Provision
Government’s have asymmetric knowledge
of markets

Government Failure – Black Market

Nanny State – Does not leave economic

Solving Tragedy of Commons – The
Negative overuse or exploitation of
Production resources, (oceans, forests, air),
Externalities that are not owned by
individuals/organisations
MSC > MPC
Cost to 3rd Parties (Pollution)
Producers ignore social cost
Over—Produced
Welfare Loss from the Socially
Optimum Level
agents to make decision based on price
mechanism
Very Difficult to Distribute Rights
E.g. To Sea and Air
Opportunity Cost of Administration and
Enforcement
Dependent on enforcement, in order to be
successful
Pollution Permits – Combines the
market forces and regulation to
allow carbon dioxide emissions
Government issue permits
Firms can invest in Green
Technology, reduce production or
buy permits
 Property Rights – The legal
rights of ownership of use of an
economic resource
Government When Government Intervention
Failure in the market reduces overall
welfare.
Worse she the misallocation of
Resources
E.g. Black Markets
Green Homes Grant
Regulatory Capture – Causing
the 2008 Financial Crisis
Increase incentive to maintain
resource
MPC increases (closer to MSC)
Reduces Over-production
Reduces Welfare Loss
Closer to Socially Optimum Level
International Market Failure requires
International solution
E.g. Tackling Climate Change
High Opportunity Cost, which without
Budget Surplus, must be funded either
through borrowing (increasing future
taxation), or financial cuts to other public
sectors
If Government failure is very high, there is
rationale for no intervention even if market
failure occurs.
Overtime Government reduces
the number of permits in the Free
market
However,
Opportunity Cost
Difficulty Setting Cap at Correct
Level (can be adjusted in LR)
Free Market Economic Theory
Theory of the Invisible Hand
Economic Agents will maximise
social utility if everyone acts in
their individual best interest

Benefits should outweigh the costs

Government intervention should be

avoided, in order to reduce the risk of
Government Failure